This is a discussion that can get really fucking complicated really fucking quickly, so to simplify, think about it this way. China is trying to squeeze leverage from its shadow banking complex while keeping credit to the real economy flowing. New RMB loans represents credit to the real economy, and everything else in the TSF figure is shadow credit. So if Beijing’s plan is working, new loans will remain robust while the aggregate financing total will tick lower (again, that is a gross oversimplification, but that’s on purpose).

Basically, you want the dark blue bars in the visual below to keep rising while other sources of credit growth (any other color bars) to tail off:

(Barclays)

Zooming in, this is a more granular breakdown (pay attention to the second straight month of falling entrusted loans):

Here’s Goldman’s take on the data we got on Wednesday (you’ll note it backs up our assessment of how you should look at these numbers):

Do also note the bit about TSF and M2 converging. You’ll recall that a rising M2 multiplier is perhaps a warning sign that risky lending might still be running rampant. That’s something we discussed late last month on the way to showing you the following chart:

Here’s Goldman again:

TSF balance yoy growth remained stable at 12.5% yoy, while M2 yoy growth fell to 9.6% from 10.5% in April largely due to lower nonbank financial institution deposit and interbank investment growth. We view this as the result of successful collaboration among regulators to rein in excessive financial leverage, while maintaining a flexible policy stance to continue supplying credit to the real economy.

So what you’re seeing is what we might call “targeted tightening.”

That is, they’re trying to rein in shadow lending and anything that finances risk taking while preserving the credit impulse to the real economy. It’s a tough thing to do but it looks like they’re kinda, sorta pulling it off.

But – and this is a very big “but” – no one is really sure where all the credit extended via the channels they’re squeezing ended up or what it ended up financing.

It is quite literally a guessing game.

You just have to squeeze and hope nothing horrible happens. Invariably, bubbles will burst that you didn’t even know existed. Yield curves will invert. Metals mayhem will ensue. The bond market will suddenly crater. That’s part of it. And we’ve seen all of those things over the past six months.

Here’s how Goldman explained it in a note out earlier today:

The recent round of tightening in China raised renewed concerns over demand for commodities in the country. In fact, after the Chinese 7-day repo rate spiked in March, iron ore prices have fallen 40%. Unlike previous tightening policies that were mostly broad-based, the current tightening appears to be more “selective”. Exhibit 1 shows that entrusted loan and corporate bond issuance contracted notably in early 2017 but bank loans continued to grow at a brisk pace. Can Chinese demand for commodities withstand such targeted tightening?

Mercifully, Goldman finds that “bank loans tend to have the strongest correlation with commodity demand and the real economy historically [while] the correlations for other types of credit including entrusted loans and corporate bonds seem to be weaker.”

In other words: squeezing the shadow channels may not necessarily portend further commodities chaos.

In any event, the numbers and dynamics outlined above mean more for the global economy and markets than any Fed hike and you’d do well to remember that going forward, lest you should wake up one morning and wonder what the fuck happened overnight.

Writing about a subject is the best
way to educate yourself about it, and when I flick through past work I remember how much
they taught me, if no one else. Mainly they taught me that I didn’t know very much. But they
also taught me that most other people didn’t know much either. Thus, some key themes
which stand out include the illusory control of policy makers, the presumed knowledge of
those looking to them to actively do good, the ease with which we fool ourselves, and how
best to protect capital in the face of such unavoidable uncertainty. -- Dylan Grice